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FRM Part II · FRM Exam Part II · The Rise and Risks of Private Credit

A supervisor is concerned that stress in private credit could spread to the banking system through liquidity channels rather than solvency channels. Which mechanism most clearly represents a liquidity channel?

Heavy simultaneous drawdowns by private credit funds on committed bank lines are the clearest liquidity channel. They drain bank liquidity just when funding conditions may be tight. Markdowns of directly held loans, by contrast, are a solvency or credit loss channel rather than a liquidity one.

  1. ABanks mark down the value of their own directly originated loans after defaults rise
  2. BPrivate credit funds draw heavily on committed bank credit lines to meet investor redemptions and capital calls at the same time as banks face other funding pressureCorrect
  3. CRating agencies downgrade the equity of bank holding companies
  4. DRegulators raise the countercyclical capital buffer in response to credit growth

Explanation

Simultaneous drawdowns on committed lines drain bank liquidity when funding may already be tight, which is a liquidity channel. Option A is a solvency/credit loss channel. Options C and D are not liquidity transmission from private credit.

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